Integrated security: Who will lead?

Sep 1, 1999 12:00 PM, Jeff Kessler

Four years ago, Lehman Brothers' 1995 Year-End Security Review analyzed the newly born security systems integration business and made it the star of that year's publication. We still believe that providing integrated, electronic security systems to corporate and institutional accounts is among the most attractive sectors in the $60 billion security industry. The targeted end-users are just beginning to either outsource or centralize corporate-wide security needs.

Yet in our 1995 year-end review, we predicted that 15 to 20 percent growth in the system integration sector would create a $6 billion industry by the year 2000. The sector will not be close to that revenue figure, as integration revenue growth appears to be closer to 10 to 15 percent. More importantly, profitability in the industry is still limited by gross margins of about 25 percent, which has put in jeopardy our prediction that by the year 2000 there would be several public systems integration companies for Lehman Brothers to follow. Instead of systems integration growing to $4.5 billion in the year 2000 from $1.5 billion in 1995, we now expect systems integration revenues to reach about $2.6-$2.7 billion by 2000.

WHAT IS SYSTEMS INTEGRATION? While we have been writing about it for eight years, we don't expect integrated systems to become part of Wall Street jargon just yet. Indeed, ask 10 different people in the industry what security systems integration is, and likely you will get 10 different answers.

Nevertheless, a succinct definition of integrated electronic security systems could be: A central command and control which uses a common user interface, shares data and forms a system that performs as if it were one. This means various disparate security components must talk to each other so that one system, rather than many, controls security. More than likely, it will consist of security providers selling modular, turnkey security system packages, with ranges of options. In the past, an alarm company might also have sold CCTV to a customer as an add-on service and spent extra time and money to connect two different groups of hardware.

Integrated systems, in the broadest sense, can be as simple as connecting a CCTV system to an alarm system via an RS-232 port and a video switcher. A small bank branch or casino room are typical applications.

Such systems also can be extremely complicated. Integration, in the truest sense of the word, is built around a common database, and could combine radio frequency identification cards and graphical screen monitoring of access control with monitored alarms; heating, ventilating, air conditioning (HVAC); and lighting management systems. The key is to have the various functions, sensors, data gathering units and interfaces talk to each other through software.

HOW MUCH INTEGRATION EXISTS? A recent survey by Access Control and Security Systems Integration magazine of 790 corporate, institutional and government directors of security found that 34.7 percent believed that the components of their security systems were integrated. Of that 34.7 percent, about two-thirds said that components were also integrated with other systems, with fire/emergency management and communications being by far the greatest outside integration, but with still respectable response rates (over 10 percent) for integration with other systems, such as time and attendance, HVAC and human resources. In addition, of those who responded that they had integrated security systems, about 40 percent said that systems were also integrated with other systems at other locations (i.e. remote monitoring, intranet security, etc.).

THE INVESTMENT CASE FOR INTEGRATED SECURITY COMPANIES Electronic security today makes up about $15 billion (both equipment and services) of the $60 billion spent on all forms of security. Systems that integrate various aspects of electronic security, such as CCTV with alarm monitoring, still comprise but a small fraction, about 15 percent of that $15 billion.

Gross margins in selling integrated systems can reach 40 to 45 percent, when true database integration is involved. Unfortunately, hooking up a couple of functions via a communications port and passing through the cost of the equipment with a small margin - often the case - results in job margins that are 25 percent or even less. This compares to 25 to 35 percent margins typical of simple security component manufacturers.

The up-front costs in constructing a sales and service organization, which needs to spend months, if not years, of lead time generating sales, can be daunting for small companies. Eventually, well-run companies should be able to take S,G&A costs (selling, general and administrative) from more than 100 percent of sales down to about 30 to 40 percent, as volumes increase. Fifteen percent operating margins are reasonable goals for companies generating sufficient volumes (more than $75 million in revenues) in this business.

Integrated systems are generally sold and not leased (except for some alarm monitoring companies using alarms to sell ancillary functions), so cash flow is more positive than a typical alarm account. While it is true that the recurring revenue component in integrated systems is limited to alarm monitoring and service, multi-site installations and added functionality can keep revenues coming from one client for years.

FEW SUCCESS STORIES Why hasn't the growth in integration spawned more larger and profitable companies? Up until now, there have been numerous companies moving into the security integration area, but few real success stories. If one does not include ADT's all-in-one business, Security Technologies Group (STG) Inc., a privately held company based in Plantation, Fla., is the first independent company to move past the $100 million mark - still small by Wall Street standards.

While studies indicate extensive growth in integration work, we have not yet seen much industry profit from integration. The reason may be that the industry work may still be skewed toward lower value-added integrations, and is only now moving in a material way toward more sophisticated installation and service work for customers.

For example, the least flexible and most basic form of integration is hardwire interconnection of the subsystems through connecting signals of one system to another through an intricate, electrical hardwired system. Yet this may be the most common form of what security directors define as integration.

A better approach uses a customized interface in the form of a centralized personal computer with separate communications protocols. However, this approach is expensive and totally dependent on the ability to customize the central PC program, a potential profit drain.

Looking toward 2005, we are seeing that virtually the only way to get true single-system control over all the subsystems is to set up a single integral database for multiple applications. This allows easy program revisions, enables users to add program modules and avoids tricky and expensive customization.

Integrated security system revenues were limited up until recently, due to the lack of user-friendly software and user graphics, the generally higher expense than one- or two-function, stand-alone systems, and the lack of communications standards by which components could talk to one another.

Integrators of security systems also face further challenges, such as increasing the integration with other low-voltage premise control systems, which include: facilities control - HVAC, energy, lighting; fire alarm systems - detection and annunciation; and telecommunications - voice and data.

CHALLENGES FACING THE INDUSTRY AS IT GROWS Two industry challenges are defining what generates a profit for a particularly sized company, and convincing older clients to retrofit or to buy up-to-date systems. While the ranks of large companies putting more and more sites on centrally controlled, integrated security systems is accelerating, there are still significant numbers of multi-site companies that are content to allow local plant and site managers to keep responsibility for their own facility, either with a simple alarm system or supplemented with a guard service.

The inability of many systems today to talk to each other without expensive software development is another challenge. As security system integration becomes more software-intensive, competing integrators must offer several levels of combining such functional subsystems as access control, CCTV, proprietary monitoring, video badging, intrusion detection and fire alarms. These levels will depend on whether the various subsystems merely talk to each other via separate databases and a central translator, or whether they are truly integrated and share the same database.

Different communications protocols are used by different manufacturers. Therefore, making disparate parts of a system talk the same language can be difficult, particularly when the integration computer uses RS-232 and must communicate with equipment using other protocols.

Conclusion: The growth is there; the value-added has to grow to increase margins and allow larger companies to emerge.

In sum, the systems integration business appears to be growing at a 10 to 15 percent rate, which is among the fastest rates in the security industry. However, because of the level of integration still being done at many sites, with lower value-added and little follow-on service, profits for have not spawned as many large companies as we would have thought.

However, with software-based functionality becoming part of everyday security systems, the need not only to install, but to provide ongoing service to these increasingly sophisticated systems also increases. For example, more and more integrators are being asked to provide CCTV and access control systems that can be monitored remotely.

It is likely that the 34.7 percent of the survey respondents who said their systems were integrated can grow to 50 percent by 2005. If this growth combines with greater value-added aspects, there will be enough profitable revenues in the industry to generate more consolidation and spawn a number of publicly held companies, the ones we have been preparing to write about for eight years.

The $1.5 billion, recently born integrating security systems business: * increases the value-added and profit margins of those that are successful at it,

* increases the overall growth and acceptance of the security industry, which up until now has been dominated by thousands of very small companies, many with razor thin component-type profit margins, and

* increases the interest of outside corporations in the security industry, leading to further consolidation of the industry.

If a company does not have the means to put someone in front of a console 24 hours a day, or if a company is small enough that it does not have much area to protect, then they are probably not candidates for an integrated system.

Want to use this article? Click here for options!
© 2012 Penton Media Inc.

This month in Access Control

• Targeting The Customer
• Electronic Pedigrees
• One Hero Among Many
• Who? What? When? Where? Why?
• More from September's issue